For many investors, 2022 was a year they would happily forget. A confluence of macro events including the historical global shift in interest rate policy, persistent inflationary pressures and geopolitical concerns all led to a challenging environment to navigate. The war in Ukraine, the resulting supply chain disruption, recession fears, and a tumultuous winter for crypto assets, spelled a turbulent year for risk assets.
For some investors, however, it provided an opportunity to take positions that for a long time were challenged in an ultra-low interest rate environment with buoyant asset prices. Strategies that focused on navigating through rising interest rates, embracing volatility, and refocusing on fundamentals presented an opportunity to generate alpha and beat benchmarks. Some market commentators said it was the perfect environment for active investors to shine.
From a securities finance perspective, demand was relatively robust throughout 2022. We observed the following trends1:
- Hard to borrow securities remained concentrated throughout the year in key sectors such as crypto, real estate, and technology with U.S. and Asian equities mostly in focus
- There was an increased demand for ETFs as borrowers sought wider exposure and less focus on specific securities
- Corporate bond demand had a banner year as valuations increasingly came under pressure and interest rates continued to rise
- In the U.S., demand for leveraged loan ETFs and preferred stock was also noteworthy. Where senior loan ETFs are widely considered safe and reliable investment instruments, the recent volatility of the credit markets has created instability in the space and has driven subsequent lending demand
- Across EMEA, airlines and travel related firms were in focus as they slowly recovered post-pandemic, while the real estate sector faced renewed pressure due to rising indebtedness and interest rates.
Looking ahead, here are our predictions of the top five trends that could drive securities finance activity in 2023:
Top 5 Securities Lending Demand Predictions for 2023
1. Volatility provides fertile ground for stock picking among some hedge funds, while recession concerns weigh down on some sectors
The hawkish turn in global central bank policies that led to increased volatility in 2022 is expected to persist in 2023. Elevated volatility and single stock dispersion provide fertile ground for stock picking among equity long-short hedge funds.
Separately, recession concerns are likely to weigh on investor sentiment. Anxiety about the potential length and depth of a downturn may place additional pressure on sectors such as consumer discretionary and luxury goods. Entertainment, leisure/travel, including airlines, hotels and other tourism related firms, may struggle as consumer spending potentially becomes constrained.
In addition, as Fed funds futures point to rates rising above 5% in Q2 and market forecasts begin to price in potential rate cuts for the second half of the year, additional opportunities for cash re-investment desks may present themselves.
2. China re-opening likely to drive increased opportunities
China’s unwinding of “zero-Covid” and domestic spending will likely be a significant catalyst in 2023 and could drive increased opportunities. Although the removal of restrictions has been broadly welcomed, the ushering in of the new policy could generate potential risks, including rising infection rates, which may impact productivity.
Separately as China’s economy begins to reopen, global supply chains could be under further pressure, particularly the automobiles and technology sectors. Furthermore, inflationary pressure may rise as China increases its demand for commodities and raw materials such as copper, gas, oil, and steel.
3. Real estate stocks to remain among the top hard to borrow
The real estate sector is likely to remain under pressure. Many firms are heavily indebted and rising interest rates could mean that they may need to go to the market to raise capital and bolster balance sheets. In Europe, property companies are also expected to experience significant pressures as borrowing costs increase and valuations drop. Several real estate investment trusts (REITs) and property managers, such as SBB in Sweden and Hammerson and Home REIT in the U.K., were among our top hard to borrows in 2022, and we expect that to continue into 2023.
4. Tech stocks likely to remain a key focus amid economic headwinds and regulation
The technology sector is likely to be a key focus as companies continue to increase attention on costs by paring back on headcount in the face of increasing economic headwinds. Cryptocurrency-exposed firms may remain under pressure as fraud and solvency concerns plague the crypto market. Global regulators are likely to move swiftly in 2023 to address a lack of oversight, creating additional challenges to crypto-linked stocks in the short-term. In Hong Kong, the mainland Chinese tech sector remains threatened given regulatory tightening and continued anti-trust scrutiny that began in 2020.
5. Demand for electric vehicles (EV) stocks shows no sign of abating
Focus on EVs is expected to continue. Lending demand has shown no signs of abating as many relatively nascent companies such as Lucid Group, Nikola Corp, and XPeng continue to settle into their valuations and thus remain highly susceptible to changes in cost of capital increases and consumer behavior.
Conclusion
In summary, 2022 will likely go down as one of the most challenging years in recent history for many investors as they had to navigate a time of change and uncertainty. However, the volatility that ensued in global markets provided some attractive opportunities for some investors who were able to hedge appropriately. We expect several of these themes, in addition to the looming threat of recession, will continue to impact markets and thus provide opportunities for investors and help drive securities finance demand in 2023.
1 Observations made by BBH Securities Lending Team based on various data sources
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